Spain May Use Its Debt Instead of Cash for Bankia Group

By Emma Ross-Thomas and Charles Penty -
May 28, 2012

Spain is considering using debt
issued by the government or its bank-rescue fund instead of cash
to prop up the Bankia group, adopting a mechanism that would
free it from raising the money from investors.

The government hasn’t made a decision on whether to use its
debt to recapitalize the nationalized lender and will decide in
two or three months, a spokesman for the Economy Ministry, who
asked not to be named in line with its policy, said in a phone
interview today. Prime Minister Mariano Rajoy said at a Madrid
news conference today the government hadn’t spoken to the
European Central Bank about such a step.

Spain nationalized the Bankia group on May 9, leading the
lender with the biggest Spanish asset base to request 19 billion
euros ($23.9 billion) of government backing to clean up lending
to property developers and other loans such as residential
mortgages. The size of the support needed for Bankia, and the
implication that other banks may also need state support to
repair their balance sheets, pushed 10-year yields today to the
most relative to German bunds since the euro was created.

“It’s getting increasingly ugly because of the circularity
of the problems,” said Georg Grodzki, who helps oversee $515
billion at Legal & General Investment Management in London,
adding that 19 billion euros “now seems too much” for the
Spanish government to raise directly in the markets. “The
phrase ‘house of cards’ comes to mind.”

Bankia Shares Fall

Rajoy repeated at today’s news conference that Spain has no
plans to seek a European Union bailout for its banks. Even so,
he said the euro region’s bank rescue fund should be able to
bypass national governments and recapitalize lenders directly.

The nationalization of Bankia, a group with an asset base
that’s about a third the size of Spain’s gross domestic product,
wouldn’t affect the country’s budget deficit, said Rajoy.
Spanish newspaper El Pais reported the plan to use government
debt yesterday.

Bankia shares fell as much as 29 percent in Madrid and
closed 13 percent lower at 1.36 euros. The yield on Spain’s 10-
year bonds climbed more than 16 basis points, or 0.15 percentage
point, to 6.45 percent at 5:49 p.m. in Madrid.

Record Spreads

The Spanish-German spread expanded to as much as 513 basis
points, the most since the euro’s introduction in 1999, and was
last at 511 basis points. Rajoy said today the nationalization
of Bankia had no impact on the Spanish spread.

Shares in other Spanish banks slid today as investors
weighed the likelihood that the bigger cleanup of Bankia would
also force them to make more provisions than those already
ordered by the government. Banco Popular Espanol SA (POP) fell as much
as 8.3 percent before closing 7.5 percent lower and CaixaBank SA (CABK)
fell 5.1 percent and Banco Santander SA (SAN) 3.2 percent.

The Bankia group’s announcement of its need for government
support “surely raises the bar and may set the basis for what
other banks may be expected to do in terms of incremental
impairments,” Carlos Berastain, an analyst at Deutsche Bank AG
in Madrid, said in a report today.

Based on what happened at Bankia, the recapitalization
needs of Spain’s banks could amount to as much as 60 billion
euros, Daragh Quinn, an analyst at Nomura International, said in
a report today. “Given the current economic and political
uncertainties facing the euro zone, this could see additional
pressure on Spain to consider using external funds for the bank
recapitalization,” he wrote.

‘ECB Scam’

Spain established a mechanism in February for using debt
issued by the government or the bank-rescue fund, known as FROB,
to recapitalize banks. Lenders can use government-issued debt as
collateral to borrow from the ECB. The FROB has 5 billion euros
of available funds, leaving its ability to bail out lenders
dependent on Spain’s access to markets.

“It takes the ECB scam to a new level -- not only has it
become the lender of first resort for large parts of the euro-
zone banking system but it is now also being abused as a source
of capital,” Grodzki said in a phone interview today, referring
to the possibility that the government may recapitalize Bankia (BKIA)’s
parent company with its debt.

An ECB spokesman said in a phone interview that its
“monetary policy framework operates as usual” and that it
would refer questions on Bankia’s recapitalization to
authorities in Spain.

Risks to Spain’s financial industry and the state are
becoming increasingly intertwined as the government’s access to
borrowing narrows.

Foreign investors cut their holdings of Spanish debt of 37
percent Spain’s total outstanding debt in circulation in April
from 50 percent at the end of last year. Domestic lenders,
bolstered by emergency funding from the ECB, have picked up the
slack, increasing their share to 29 percent from 17 percent over
the same period.